As the coronavirus outbreak reaches a crisis in Europe, Ramsay Health Care ((RHC)) is faced with the deferral of elective procedures at its hospitals. France has decided to cancel or defer non-urgent elective surgery and other countries are expected to follow.
The company has withdrawn FY20 guidance because of the uncertainty. Yet, while the near-term may be affected, one thing is well known. An ageing population means the demand for surgery will continue to grow.
Ramsay Health Care is currently in discussions with the UK public health service to provide for any overflow and this is likely to occur in Australia as well. The company will assist with any acute surgical work initially, followed by more medical work as public hospital capacity is reduced.
Brokers assume the lower elective volumes are only partly offset by the increased outsourcing from the public sector. UBS, because of this, makes no changes to revenue and earnings forecasts in Europe due to the inability to quantify the impact.
In Australia, the broker reduces private hospital volume growth in the second half and factors in a recovery in FY21. However, with a high fixed cost base, UBS points out, lost revenue will flow directly to earnings.
With no shortage of patients and amid funding commitments from governments, Ord Minnett remains confident the business can continue to generate a profit, even if this is reduced. Macquarie considers the earnings impact for Australia is likely to be less than Europe, because the company’s asset ownership position is favourable in the current environment.
The broker continues to believe the business is well-positioned for growth in the longer term via brownfield developments at key sites in Australia, stable tariffs in France and the benefits from the Ascension joint venture from FY21 onwards.
Debt
Elevated debt metrics may be a cause for concern, although Ord Minnett is comfortable sufficient cash can be generated. Much of the debt is held in European joint ventures and is non-recourse to the company.
Based on UBS estimates net debt/EBITDA would be 3.9x in FY21. The broker assumes an allowance will be made for a technical breach (if the covenant is 3.5x) because of a likely recovery in FY22. However, should elective surgery deferrals drop more rapidly than forecast and there are more limited payments from the public system the broker does not rule out the need for equity.
Citi upgrades to Buy from Neutral. The broker assesses the debt position of the company is strong and, when the pandemic subsides, the relative value of hospital infrastructure will be enhanced.
Credit Suisse also suspects that there will be a resurgence in elective private hospital volumes as public hospitals will remain constrained even when the impact eases. Despite the stock having more defensive earnings compared with the broader market, the broker notes it has underperformed since the peak in February.
With a more positive outlook, and noting sufficient liquidity and capacity for growth, Credit Suisse raises the rating to Outperform from Neutral. The broker maintains current earnings forecasts, with a view that it remains possible these will be even be supported as elective surgery is brought forward and some government services are moved to the private sector.
However, over a longer timeframe this is hard to predict, although as the crisis is likely to last less than 6-12 months it has little impact on valuation, in the broker’s view. A one-off -25% decline in operating earnings forecasts for FY21 would reduce the valuation by just -5%.
Assuming a -10% reduction in global volume for the June and September quarters, and a 25:75 variable fixed cost base, Morgan Stanley reduces FY21 and FY22 estimates for earnings by -21%. While there may be some offset from public-sector volume, the broker suspects this will involve lower tariffs and therefore provide lower margins.
Value Proposition
The assessment of whether the stock is cheap is still difficult, in Morgan Stanley’s view. Moreover, long-term issues of Australian margins and the debate about the value of private health insurance will still be there when the virus has passed.
Around 55% of surgeries are conducted in the private sector in Australia and Ramsay Health Care has around 30% share of the private hospital market. Most services, even if deferred, are expected to get done sooner or later.
This is particularly the case for surgical procedures. However, UBS does not expect Australian private hospital growth will return to historical levels. The broker suggests pricing will remain an issue because of the level of price increases the hospitals can achieve from insurers.
In the event of a prolonged recession, Citi acknowledges the percentage of the population with private health insurance will decline and this could have an impact on the private hospital sector. However, this outcome is not in the broker’s base case.
Although Ord Minnett is not calling the bottom of the market, given deep uncertainty, the pressures on hospital affordability are expected to grow amid the disruption to the economy caused by the outbreak.
Yet, even in the event of a precipitous decline in health fund membership, the need for the company’s hospitals will not diminish, the broker asserts. Furthermore, the weakness presents an opportunity to build a position the stock and Ord Minnett upgrades to Accumulate from Hold.
FNArena’s database has four Buy ratings, two Hold and one Sell (Morgan Stanley). The consensus target is $65.91, suggesting 21.4% upside to the last share price.
